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GO BONDHOLDERS SUE PUERTO RICO BASED ON PROMESA

Ever since President Obama signed PROMESA into law, Governor García Padilla crowed that now bondholders could not sue PR. Not only was he wrong, he was proven wrong today when a group of GO bondholders sued him for violating PROMESA.

The Group, that includes Lex Claims, LLC, Jacana Holdings (who also sued in NY Supreme Court), MPR Investors, Rolgs, RRW and SL Puerto Rico Fund, not Stone Lion and Aurelius as originally reported by Reuters. They claim, quite correctly in my view, that PROMESA prohibits the default of GO’s Governor García Padilla has done. Plaintiffs invoke section 204(c)(3) of PROMESA which states:

“During the period after a territory becomes a covered territory and prior to the appointment of all members and the Chair of the Oversight Board, such covered territory shall not enact new laws that either permit the transfer of any funds or assets outside the ordinary course of business or that are inconsistent with the constitution or laws of the territory as of the date of enactment of this Act, provided that any executive or legislative action authorizing the movement of funds or assets during this time period may be subject to review and rescission by the Oversight Board upon appointment of the Oversight Board’s full membership.”

The complaint avers, quite correctly, that the PR Constitution guarantees the payment of GO’s as a priority, see Article VI, sections 2 and 8. Moreover, PR law prioritizes the payment of this Constitutional debt. Although Governor García Padilla justified his default on the GO debt on the power granted to him by the Moratorium law enacted by the PR legislature, the complaint points out that it is preempted not only by 11 U.S.C. § 903 but also by section 303 of PROMESA.

Plaintiffs also aver that not only is the default on GO’s a violation of the PR Constitution and hence PROMESA, but that the 2016-17 budget is a violation of both laws since it does not budget for the payment of the Constitutional debt. It cites Article VI, section 6 of the Puerto Rico Constitution, which states:

“If at the end of any fiscal year the appropriations necessary for the ordinary operating expenses of the Government and for the payment of interest on and`amortization of the public debt for the ensuing fiscal year shall not have been made, the several sums appropriated in the last appropriation acts for the objects and purposes therein specified, so far as the same may be applicable, shall continue in effect item by item, and the Governor shall authorize the payments necessary for such purposes until corresponding appropriations are made.”

Since the 2015-16 budget did include appropriations for GO’s, the Constitution requires that these appropriations be used for payment of the GO debt and plaintiffs in this case so demand. Again, the claim is that violating the Constitution’s provisions on payments also violates PROMESA.

Plaintiffs also aver that this complaint is not stayed by PROMESA. As I have discussed before, the stay in PROMESA applies to cases filed after December 18, 2015 and seek:

“(1) the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the Government of Puerto Rico that was or could have been commenced before the enactment of this Act, or to recover a Liability Claim against the Government of Puerto Rico that arose before the enactment of this Act;

(2) the enforcement, against the Government of Puerto Rico or against property of the Government of Puerto Rico, of a judgment obtained before the enactment of this Act;

(3) any act to obtain possession of property of the Government of Puerto Rico or of property from the Government of Puerto Rico or to exercise control over property of the Government of Puerto Rico;

(4) any act to create, perfect, or enforce any lien against property of the Government of Puerto Rico;

(5) any act to create, perfect, or enforce against property of the Government of Puerto Rico any lien to the extent that such lien secures a Liability Claim that arose before the enactment of this Act;

(6) any act to collect, assess, or recover a Liability Claim against the Government of Puerto Rico that arose before the enactment of this Act; and

(7) the setoff of any debt owing to the Government of Puerto Rico that arose before the enactment of this Act against any Liability Claim against the Government of Puerto Rico.”

The complaint states that it does not seek payment of the defaulted amounts and hence the stay is inapplicable. That argument has also been made in Brigade Leveraged Capital Structures Fund, Ltd. v. García Padilla, 16-1610; National Public Finance Guarantee Corporation v. García Padilla, 16-2101 and Trigo v. García Padilla,16-2257. I expect Judge Besosa to rule on this and other issues in these cases by August. Only in Ambac Assurance Corporation v. Puerto Rico Highway and Transportation Authority, 16-1893 has the plaintiff acquiesced to the stay since it is seeking a receiver for the defendant. No such receiver is sought by the GO plaintiffs and it is my opinion that the Court will rule that the stay is not applicable to the case.

In addition, plaintiffs point out that millions of dollars were clawed back by PR and that the only justification for such clawback would be to pay for the Constitutional debt but it has gone instead to debts of lesser priority. Again, this could be considered a violation of PROMESA since it violates the PR Constitution. Also “[a]dding insult to constitutional injury, the budget contemplates an increase of more than $500 in non-debt service spending.” Page 19, paragraph 54. This includes an increase of $150 million from the previous year’s contribution to the retirement funds. I can see the malevolent hand of the US Treasury helping its ally, organized labor.

The complaint also seeks, similar to the complaint in the aforementioned Brigade case, the lifting of the stay if the Court believes it is necessary. Clearly an averment made in an abundant of caution. Not a bad idea.

transfers outside the ordinary course of business or in violation of Puerto Rico’s Constitution and laws to the detriment of holders of Puerto Rico’s Constitutional Debt are invalid under Section 204(c)(3) of PROMESA.

Enjoining enforcement or implementation of certain of those measures until the

Oversight Board has made a determination as to their propriety, with such injunction:

(1) requiring the Defendants, in their official capacities as Commonwealth

officers, to segregate and preserve all funds clawed back, to be clawed back, or available to be clawed back under contractual and legal provisions expressly acknowledging that those funds are subject to turnover for purposes of paying of Constitutional Debt;

(2) prohibiting the Defendants, in their officials capacities as Commonwealth officers, from implementing the outsized transfers to the public employee pension funds contemplated in the Fiscal Year 2017 budget and limiting the Commonwealth to the contribution it made in Fiscal Year 2016; and

(3) prohibiting the Defendants, in their official capacities as Commonwealth officers, from implementing the diversion to the insolvent GDB the approximately $250 million contemplated by the Fiscal Year 2017 budget, or such other amounts (such as

those allocated in pending legislation).

In synthesis, it is a well-written complaint with a good chance of being granted the remedies it seeks. There is, however, one concern. Section 204(c)(3) mentions the Board but does not specifically state that those affected by these violations would have a cause of action. Clearly, GO bondholders have standing since they have not been paid but the question really is whether they have a cause of action. This question, I believe, is ruled by Gonzaga Univ. v. Doe , 536 U.S. 273 (2002) and that plaintiffs do have a cause of action if not under PROMESA, definitely pursuant to 42 U.S.C. § 1983. We shall soon find out.